Answer to Question #249228 in Macroeconomics for Biba

Question

7. à ¢ € œChanges in disposable income lead to movements along the consumption function; changes in wealth or other factors lead to a shift of the consumption function.à ¢ €  Explain this statement with an illustration of each case.

Answer 1

The consumption function shows a relationship between disposable income and consumption. Hence, a change in disposable income will cause a movement along the consumption function. In the figure below, an increase in income from Y0 to Y1 increases consumption from C0 to C1 and causes a rightward movement along the consumption function from point A to B. On the contrary, if the disposable income declines from Y1 to Y0, consumption falls from C1 to C0 and causes a leftward movement along the consumption function from B to A. 

Change in the non-income factors such as wealth and expectations results in a shift in the consumption function. Non-income determinants are autonomous factors and thus results in a shift. In the figure below, when there is an increase in wealth, the consumption function will change upwards from C2 to C1. Conversely, a decline in wealth will cause a downward shift in the consumption function from C1 to C2.